Tag Archives: #riskoff

Problems Galore

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The story continues to be
The China of President Xi
Has problems galore
With more still in store
So, traders, as such, want to flee

The issue for markets elsewhere
Is knock-on effects aren’t rare
Protecting the yuan
Means it is foregone
Bond sales will send yields on a tear

For yet another day, China is offering the biggest market stories.  In no particular order we have seen the following overnight; China Evergrande filed for Chapter 15 bankruptcy, a process by which foreign entities can access the US bankruptcy court system, regarding $19 billion of their offshore debt; the PBOC set their CFETS fixing more than 1000 pips lower than market expectations, the largest gap since the process began in 2018, in their effort to arrest the yuan’s consistent decline; and Chinese police visited the homes of the protesters who were complaining about Zhongzhi’s missed payments (I wrote about these Monday in Risks Were Inbred).  And this doesn’t include the fact that Country Garden, the largest property developer in China is losing money quite rapidly and may also be on the brink of bankruptcy.  It seems the Chinese property bubble is deflating.

Ultimately, there appear to be two main impacts of the gathering storm in China, market participants are increasingly leery of taking on risk in general, and the PBOC’s efforts to stem the decline of the yuan means they must sell their holdings of Treasuries to generate the dollars to deliver into the FX market thus adding downward pressure to the bond market.  Of course, one of the typical outcomes of a risk-off attitude is that bond markets rally as investors exit equities and run to bonds.  This stands at odds to the recent bond market behavior, although it is quite evident this morning.  In fact, after touching yields above 4.30% in the 10yr Treasury yesterday, this morning we have seen a half-point rally with yields declining about 5bps in the US.  In Europe, the yield declines have been even greater, mostly around -10bps, so this is a real reprieve for bond markets everywhere.

The key question here is whether we have seen the worst, or if other potential selling catalysts will appear.  Consider for a moment the fact that between China and Japan, they represent >26% of foreign owned US Treasury debt, and that both of these nations are dealing with rapidly weakening currencies.  Not only that, but both have demonstrated they are quite willing to intervene in FX markets to arrest those declines, and as mentioned above, that typically requires selling Treasuries.  It’s a self-reinforcing cycle as higher yields beget currency sales which beget Treasury sales to intervene, which results in higher yields starting the cycle all over.  

With this in mind, we need to consider, what can break the cycle?  Well, if the Fed were to turn dovish and indicate they agreed with the futures markets that rate cuts are coming early next year, I suspect the dollar would fall against most currencies, especially these two, and the cycle would break.  Alternatively, China could step up and guarantee the debt of Countrywide and Evergrande thus removing the investor risk and reduce pressure dramatically.  Finally, I suppose the Fed could make a deal with the BOJ and PBOC and directly absorb their bond sales, so they never hit the market while restarting QE.  That, too, would likely end the cycle.  It is possible there are other ways to break the cycle, but I doubt we will see any of these occurring anytime soon and so the cycle will have to wear out naturally.  That will occur when either or both of the currencies decline far enough so the market believes the trade has ended and unwinds their short positions.  In other words, none of this has changed my view that 7.50 is on the cards for USDCNY as the year progresses, very possibly with 10yr yields getting to 4.5% or more.  And don’t be surprised if we see another move to 150.00 in USDJPY.

But, away from the China connection, things are very much in the summer doldrums.  Equity markets have been treading fearfully and continue to do so this morning.  However, while we have seen several days of declines, there has been no panic selling of note.  So, yesterday’s US weakness was followed by selling throughout Asia and this morning in Europe with most markets down about -1.0%.  US futures, too, are softer, down about -0.5% at this hour (8:00).

Oil prices (-0.85%) which stabilized yesterday, are back under a bit of pressure on the overall negative risk sentiment as they continue to trade either side of $80/bbl.  Metals prices, meanwhile, are mixed with precious metals finding a bit of support while base metals suffer today.  The most interesting story here I saw today was that CODELCO, the world’s largest copper miner in Chile, may be going bankrupt as previous projects didn’t pan out.  That strikes me as a very large potential problem, but one for the future.  

Finally, the dollar is mixed this morning.  It had been softer overall in the overnight session, but as risk is getting marked down, the dollar is gaining strength.  The biggest mover has been PHP (+1.1%) which rallied after the central bank indicated they were going to put a floor under the currency and adjust rates accordingly.  After that, the EMG bloc has not done very much, +/- 0.25% type activity.  However, just recently, G10 currencies started to slide with NOK (-0.8%) the laggard as oil slides, but the entire bloc now coming under pressure.  This is all about risk off.  

There is no US data today nor are there any Fed speakers.  As such, the dollar will take its cues from the equity markets, and the bond market to some extent.  Right now, equity weakness is driving the risk attitude and that means the dollar is likely to remain bid into the weekend.  Next week brings the Fed’s Jackson Hole meeting where everybody will be looking for any policy hints by Chairman Powell on Friday morning.  But for now, the dollar is on top of the mountain.

Good luck and good weekend

Adf

Risk Were Inbred

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In China, the problems have spread
From property company dread
To shadow finance
Where folks took a chance
To earn more though risks were inbred

And elsewhere, the Argentine voters
Surprised governmental promoters
By choosing a man
Whose primary plan
Is ousting Peronist freeloaders

While the goal of this commentary is to remain apolitical, there are times when the politics impacts the markets and expectations for future movement so it must be addressed, though not promoted on either side.  Today, amid general summer doldrums, it seems there are more political stories around that are either having or have the potential to impact financial markets.

But first, a quick look in China where the latest problem to bubble to the surface comes from Zhongzhi Enterprise Group Company, one of the many shadow banking companies in the country.  These firms are conduits for investment by wealthier individuals and corporations who offer structured products and investments promising higher returns than the banking sector.  And they are quite large, with an estimated $2.9 trillion invested in the sector.  Well, Zhongzhi has roughly $138 billion under management and last week they apparently missed some coupon payments on several of these high-yielding investments.  While this is the first that we have heard of problems in the sector, given the terrible performance of the Chinese equity market as well as the ongoing collapse of the Chinese property market, my guess is this won’t be the last firm with a problem.  As has often been said, there is never just one cockroach when you turn on the lights.

As proof positive that there is really no difference between the Chinese and US governments, the first response by the Chinese was to set up a task force to investigate the risks at Zhongzhi and its brethren shadow banks.  That sounds an awful lot like what would happen here, no?  Anyway, depending on who is invested in Zhongzhi and whether they are politically important enough to bail out, I suspect that there will be government intervention of some sort.  Do not be surprised to hear about Chinese banks making extraordinary loans to the sector or guarantees of some kind put in place.  The last thing President Xi can afford at this time is a meltdown in a different sector of the financial space.

It can be no surprise that Chinese equity markets were under pressure again last night, with both the Hang Seng and CSI 300 falling sharply, nor that the renminbi has fallen to its weakest levels since the dollar’s overall peak last October.  I maintain that 7.50 is in the cards here and that it is simply a matter of time before we get there.  In the end, a weaker CNY is the least painful way for China to support its economy, especially since it is a big help to its export industries which remain the most important segment of the economy.  Later this week we will see the monthly Chinese data on investment and activity so it will be interesting to see how things are ostensibly progressing there.  However, this data must always be consumed with an appropriate measure of salt (or something stronger) as there is no independent way to determine its veracity.

Meanwhile, on the other side of the world, a presidential primary in Argentina resulted in a huge surprise with Javier Milei, a complete outsider and ostensible free market advocate, winning the most votes, more than 30%.  The election comes in October and the ruling Peronist party is at risk of being eliminated in the first round.  What struck a chord in the country was his plan to dollarize the economy and close the central bank as well as to shut down numerous government agencies.  Inflation there remains above 115% so it can be no surprise that someone who promised to change the process garnered a lot of support.

I raise this issue because in Germany, the AfD (Alternative für Deutschland) party is currently polling at >21%, the second largest party in the country, and that has a lot of people very concerned.  Like Senor Milei, the AfD’s platform is based on destruction of much of the current government setup.  Because this party is on the right, and given Germany’s dark history with the far right, the latest idea mooted has been to ban the party completely.  Now, certainly the idea of a resurrection of the Nazi party is abhorrent to everyone except some true extremists, but simply banning the party seems a ridiculous idea.  After all, the members will either create a new party with the same support or take over a smaller existing party and drive the platform in the desired direction.  

Support for Marine LePen in France continues to grow, as does support for right of center parties throughout Europe, especially Eastern Europe.  And of course, here in the US, the upcoming election has fostered even more polarization along partisan lines with the Republican party seeming to gain a lot of support of late.  All this implies that there is a chance of some real changes in the financial world that will accompany these political changes.  At this point, it is too early to determine how things will play out, but as we are currently in the Fourth Turning, as defined by historian Neil Howe, the part of civilization’s cycle when there is great unrest, I expect there will be a lot more change coming.  Food for thought.  And it is for this reason that hedging exposures is so critical.

Ok, last week’s inflation readings were mixed, with CPI a bit softer than forecast while PPI was a bit firmer.  But the one consistency was that Treasury yields rose regardless of the situation.  After a further 5bp rise on Friday, 10yr yields are unchanged at 4.15% this morning, an indication that inflation concerns remain front of mind for most investors.  I expect that the peak yields seen back in October will be tested again soon.  As to European sovereigns, while yields there are down a tick this morning, the trend there remains higher as well.

Equity markets, too, have had some trouble of late, sliding a few percent over the past several weeks.  While the move lower has been modest so far, there is clearly concern over a technical break lower should the indices break below their 50-day moving averages.  With yields heading higher, I fear that is the path of least resistance for now.

Oil prices are a touch softer this morning but remain well above $80/bbl and appear to be consolidating before their next leg higher.  Supply is still a consideration and given economic activity continues to outperform, I suspect higher is still the path going forward.  Metals prices are little changed this morning despite some incipient dollar strength, so keep that in mind as well.

Finally, the dollar is much stronger against its Asian counterparts and modestly stronger against most others this morning.  Continuing rises in US yields offer support for the greenback and increased turmoil elsewhere, along with the US economy seemingly outperforming all others have been the hallmarks of the dollar’s strength.  I don’t see that changing soon.

Data this week brings the following:

TuesdayRetail Sales0.4%
 -ex autos0.4%
 Empire Manufacturing-0.7
 Business Inventories0.1%
WednesdayHousing Starts1445K
 Building Permits1468K
 IP0.3%
 Capacity Utilization79.1%
 FOMC Minutes 
ThursdayInitial Claims240K
 Continuing Claims1700K
 Philly Fed-10.5

Source: Bloomberg

While Retail Sales will be watched for their economic portents, I think the Minutes will be the most interesting part of the week, especially as we have now had at least two FOMC voters, Harker and Williams, talk about cutting rates next year.  

For today, while US equity futures have edged higher so far, I feel like the dollar has legs for now.  This will be confirmed if yields continue to rise.

Good luck

Adf

Xi Jinping’s Dreams

Posted on by 
The 30-year bond was a flop
Which helped cause an interest rate pop
Though CPI rose
A bit less than pros
Expected, risk prices did drop

Then early this morning we learned
That lending in China’s been spurned
It certainly seems
That Xi Jinping’s dreams
Of rebounds might soon be o’erturned

For all the bulls out there, yesterday must be just a bit disconcerting.  First, the highly anticipated July CPI data was released at a slightly lower than expected 3.2% headline number with core falling 0.1% to 4.7%, as expected.  As always when it comes to CPI data, there were two immediate takes on the result.  On one side, inflationistas pointed out that the future will be filled with higher numbers going forward as base effects for the rest of 2024 kick in with very low comparables in 2022.  They also point to the medical care issue, a detail I have not discussed, but which has to do with a change made by the BLS that has been indicating medical care prices have fallen all year, but which will fall out of the mix starting in September, thus reversing one of the drags we have seen on CPI.  And finally, the rebound in energy prices is continuing (oil +0.4% today) and will be a much bigger part of future readings.  This story was underpinned today by the IEA reporting a new record demand for oil in July of 103 million bbl/day.  Demand continues to support prices here.

Meanwhile, the deflationistas point to the recent trend in prices, which shows that on a 3-month basis, or a 6-month basis, if annualized, CPI is really only running at 2.4% or 2.9% or something like that.  The implication is because we have seen a reduction in the monthly number lately, that will continue.  As well, they make the case that China’s deflation is a precursor to lower US inflation with, I believe, a roughly 6-month lag.  Perhaps the most interesting take I saw was that the Fed has now achieved their goal of an average PCE of 2% if you take the last 14 years of data.  The idea is that Average Inflation Targeting was designed to have the economy run hot for a while to make up for the ‘too low’ inflation that has been published since the GFC.  And now, that average is 2.07% for the past 14 years.  (To me, the last idea is a chart crime, but I digress.)

The problem, though, for the bulls, is that the market’s behavior was not very bullish.  Although the initial move in Treasury yields was lower, with the 10-year yield falling 6bps right after the release, the 30-year Treasury auction that came later in the day was not nearly as well-received as the shorter dated paper seen earlier in the week.  The bid/cover ratio was only 2.42 and it seems that the market may be feeling a little indigestion from all the new paper just issued, as well as the prospects for the additional nearly $1.5 trillion left to come in 2023.  It is not hard to believe that longer end yields could rise further as the year progresses.  The upshot was 10-year yields rose 10bps on the day and are unchanged from there this morning.

Similarly, in the equity markets, the initial surge on the back of the slightly softer CPI was unwound throughout the day and though all three major indices ended the day in the green, the gains were on the order of 0.1% or less, so effectively unchanged.  Looking at futures there today, all three indices are unchanged from the close as investors and traders look for their next inspiration.  Meanwhile, I cannot ignore that overnight, Asian equity markets all fell, with the CSI 300, China’s main index, down -2.30%.  As well, European bourses are all lower this morning, mostly on the order of -1.0%.  Overall, this is not a positive risk day.

One of the things adding to the gloom is the financing data from China released early this morning.  New CNY Loans fell to CNY 345.9 billion, less than half the expected amount and down from >CNY 3 trillion in June.  M2 Money Supply there also grew more slowly than expected at just 10.7% as it seems that China’s debt woes are increasing.  China Evergrande was the first Chinese property company that gained notoriety for its problems, but Country Garden was actually the largest property company in China and now that looks to be heading toward bankruptcy.  

A quick tour of China shows it has a number of very big problems with which to contend.  Probably the biggest problem is demographics as the population begins to shrink.  However, two other critical issues are the massive amount of debt that is outstanding there (not dissimilar to the US situation) but much of it is more opaque sitting on the balance sheet of local government funding vehicles.  Just like in the West, this debt will not be repaid in full.  The question is, who is going to take the losses?  In China, the central government is trying to foist those losses on the local governments, but that will be a long-term power struggle despite President Xi’s ostensible powers.  Finally, the massive youth unemployment situation is simply dry tinder added to a very flammable mixture already.  This is not a forecast that China is going to implode, just that the claims that it is set to ascend to global superpower status may be a bit premature.

(By the way, for all of you who think a BRICS gold backed currency is on the way, ask yourself this question.  Why would India and Brazil want to link up with a nation with awful demographics and a gargantuan debt problem and link their currency to that?)

Finishing up, we have a bit more data this morning led by PPI (exp 0.7% Y/Y, 2.3% Y/Y ex food & energy) and then Michigan Sentiment (71.3) at 10:00.  With CPI already released, PPI would need to be dramatically different from expectations to have much of an impact at all.  There are no Fed speakers today, but yesterday we heard that there is still more to do by the Fed from both Daly and Bostic, and Harker did not repeat his idea that cuts were coming soon.

The dollar is mixed today, with Asian currencies under pressure, EEMEA and LATAM currencies performing well and the G10 all seeming in pretty good shape, although NOK (-0.7%) is under pressure after a much softer than expected CPI number yesterday has traders unwinding some future interest rate hikes.

Speaking of future interest rate hikes, the Fed funds futures market is down to a 10% chance of a September rate hike by the Fed, although there is still a ton of data yet to come, so that is likely to change a lot going forward.  My sense is that a little bit of fear is building in risk assets as despite some ostensible good news, with lower inflation and less chance of a Fed rate hike, risk is under pressure.  One truism is if a market cannot rally on good news, then it is likely to fall, especially if something negative shows up.  In that case, I suspect that we could see weakness in equities today, weakness in bonds and strength in the dollar before it is all over for the week.

Good luck and good weekend

Adf

Failed to Inspire

Posted on by 
Consider poor President Xi
Whose efforts in his ‘conomy
Have failed to inspire
The quickening fire
Of growth for his people to see

It seems that the latest reports
Show signs of collapsing exports
Implying that growth
In China is sloth
And helping inspire yuan shorts

Chinese exports fell 14.5% Y/Y in July.  Imports also underperformed, falling -12.4%.  Perhaps of greater concern to President Xi is that they fell 23.1% to the US and 20.3% to the EU.  Now, they did rise aggressively to one place, Russia, where the increase was 52% Y/Y.  Alas for the Chinese, their business with Russia was always a fraction of that with the West, so, net, things are not looking too good on the mainland.  Ultimately, the problem for Xi is that despite years of effort to change the nature of the Chinese economy from a mercantilist model focused on export growth to a domestic consumption led model, they have not yet achieved that adjustment.  This has resulted in some very difficult decisions for President Xi which have yet to be made.

Consider that the Chinese growth miracle was built on three pillars, cheap labor, massive infrastructure spending and residential property investment.  For 18 years following the entry of China into the WTO this model was killer with average GDP growth over 10%.  It was remarkable in its ability to lift hundreds of millions of people out of poverty, a true humanitarian good.  But transition is always difficult, and China has now grown to the point where the old model is no longer effective and a new one needs to be implemented for the country’s future.

The first problem is the price of labor has risen in China to the point where it is no longer the cheapest place to manufacture goods as both India and Vietnam offer better value on this score.  Add to that the current tensions between China and the West and the efforts of western nations to reshore or friendshore manufacturing, and it seems unlikely that China is going to see a big boost in manufacturing for export anytime soon.

The second and third legs are intertwined in the following manner.  Historically, infrastructure spending has actually been financed by local governments, not by the national government except in some specific situations.  Those local governments would borrow money in the local bond markets and would use land sales as a means of repaying that debt over time.  So, as long as the property market was rising, these entities had access to additional investment funds.  When Beijing wanted to increase economic activity, they would simply instruct the local governments to pick up the pace of activity.

But now that the Chinese property market has been sinking for the past two years, which came to light with the problems at China Evergrande, but continue to this day, the Chinese people are not keen to continue to buy property as an investment vehicle, and in fact, many are looking to sell.  This has dramatically reduced the funds available for investment by local government entities and is weighing on economic activity.  This has hit both infrastructure and property investment and can be seen in the declining numbers for both Fixed Asset and Property investment that are released each month.

Thus, President Xi has very few levers to rekindle growth, especially if the west is heading into a recession.  Adding to his woes is the unemployment rate of the 16-24 set, which is currently > 21%.  In the end, China has only a limited ability to generate activity domestically at this point, and if things are slow elsewhere, they will remain slow there.

There are likely to be several direct impacts of this situation.  First, slowing growth in China is going to weigh on commodity prices as China has, for the past 20 years, been the largest consumer of commodities around.  As well, this will clearly be a deflationary impulse and weigh on price pressures, at least for certain parts of the economy going forward.  While I expect manufactured products will not rise much in price, it will probably not have much of an impact on services prices in the west, so don’t look for a collapse in inflation just yet.  And finally, a very common tactic for governments facing domestic difficulties is to try to distract their population with foreign issues.  I fear this elevates the chance for bigger problems in Asia, either with Taiwan or perhaps the South China Sea.  Xi needs to demonstrate he is still in charge so be wary.

As to the market response to this data, it was pretty negative all around.  Yesterday’s US equity rally had no real follow through with just the Nikkei managing a small gain overnight.  Not surprisingly, Chinese markets were lower along with the Hang Seng (-1.8%).  European bourses are all in the red this morning led by Italy’s FTSE MIB (-2.5%) after the Italian government imposed a 40% windfall profit tax on Italian banks.  Banks are in the firing line in Germany as well as the interest paid on reserves by the Bundesbank has been cut to 0.0%.  Do not be surprised to see this type of behavior in the US going forward, especially as the budget deficit swells.  US futures are also under pressure, down around -0.75% across the board at this hour (8:00).

In classic risk-off fashion, bond yields are falling aggressively this morning as the weak Chinese data has the recession talk back on top again.  10-year Treasury yields are lower by 10bps and now trading at 3.99%.  yield declines throughout Europe are much larger, on the order of 15bps and even JGB yields fell 3bps overnight. Suddenly there is real fear in the markets.

In keeping with the risk-off theme, commodity prices are under pressure with oil (-2.5%) leading the way and just now edging below $80/bbl.  Metals markets are also soft with copper (-2.7%) really feeling the heat although gold and aluminum are both under pressure as well.

Finally, the dollar is king of the hill this morning, rallying against all its G10 and EMG counterparts.  NOK (-1.5%) is the G10 laggard on the back of oil, but all the commodity currencies are lower by at least 1% and even the yen is softer by -0.4%.  As to the EMG bloc, again all the currencies are under pressure with the commodity bloc softest here as well.  This is a unified risk-off so buy dollars story today.

On the data front, NFIB Small Business Optimism was released at 91.9, slightly better than expected and now we await the Trade Balance (exp -$65.0B) at 8:30.  We have two speakers this morning, Philadelphia’s Harker and Richmond’s Barkin so continue to look for subtle changes in message.  Yesterday we heard from Bowman and Bostic, both indicating that more hikes might be needed to quell inflation.  I don’t believe we have seen a change there yet.

While the dollar has rallied a lot today, if equities start to retreat more aggressively, do not be surprised if this move continues.  It seems pretty clear that there is a growing concern over risk assets and, at the very least, a correction there.  That should help the dollar for now.

Good luck

Adf

Demimonde

Posted on by 
There once was a government bond
About which investors were fond
Regardless of yield
Their safety appealed
But lately, they’ve turned demimonde

So, as we await Payroll data
Demand has just started to crate-a
As yield keeps on rising
More folks are downsizing
Positions today and not late-a

It’s Payrolls Day and market participants are all anxiously awaiting the news at 8:30. Recall, last month, for the first time in more than a year, the NFP number printed slightly lower than the median forecast and that was seen as proof positive that the soft landing was on its way.  Subsequently, headline CPI fell to its lowest in two years as a confirmation of that process, and market participants decided, as one, that risk was the thing to own.  Equities rallied, bond yields fell and there was joy around the world markets. 

But lately, that story is having a rougher go of things as 10-year Treasury yields have jumped 43bps from their levels following the CPI release even though the PCE data was similarly soft.  What gives?  Arguably, part of this is because energy prices have rebounded sharply since last month, so it is increasingly clear that next week’s CPI data is going to higher than last month’s number.  As well, the growing confidence in the soft-landing scenario, which is touted across mainstream media constantly, implies that rate cuts may not be necessary.  After all, if Fed funds are at 5.5% and GDP is growing at 2.5% and Unemployment remains below 4.0%, why would the Fed change its policy rate?  The answer is, they wouldn’t.  At the same time, in the event the economy is clearly growing with positive future prospects, it is very likely that the yield curve will steepen back to a ‘normal’ shape with longer dated yields higher than short-dated yields.  If the Fed is not going to cut, that means the back end of the curve must see yields rise.  The current 2yr-10yr inversion is down to -74bps, so another 100bp rise in 10-year yields would seem realistic.

Of course, the question is, how would risk assets behave in that scenario?  And the answer there is likely to be far less positive.  After all, if risk free returns for 10 years were at 5+%, equities would need to offer a very good return opportunity to attract investors.  While there will be some companies that offer that, I suspect there are many more that would be shunned and need to reprice substantially lower to become attractive.  In other words, investors will want much lower entry prices to get involved and that could see a pretty big sell-off in the equity markets.  Just one possible scenario, but one with a decent probability of occurring, I think.

But that is all future prognostication.  In the meantime, let’s look at what the current consensus forecasts are for today:

Nonfarm Payrolls200K
Private Payrolls180K
Manufacturing Payrolls5K
Unemployment Rate3.6%
Average Hourly Earnings0.3% (4.2% Y/Y)
Average Weekly Hours34.4
Participation Rate62.6%

Source: Bloomberg

Wednesday’s ADP number was much higher than expected at 324K although the prior blowout number, 497K in June, was revised lower by 42K.  Still, 455K was much larger than the BLS report so there are many questions as to whether we will see a similar outcome today, a softer NFP number despite a very strong ADP number.  Looking at other indicators, the Initial Claims data continues to improve, hovering around 225K.  The JOLTS data was slightly softer than expected, but still right around 9.6 million and well above levels prior to the pandemic.  And finally, if you look at the employment subsets of the ISM data, they were soft in manufacturing, but solid in services, and services is a much larger part of the economy.

My take is the market is going to behave very clearly based on the actual outcome.  A strong number, anything over 225K, is likely to see the bond market sell off further and I wouldn’t be surprised to see 10-year yields, which have edged up another basis point this morning to 4.19%, trade back above the levels seen last October at 4.25% or more.  That will not be a positive for the stock markets as it will reintroduce the idea the Fed is going to continue to raise rates, something the market has completely priced out at this point.  Similarly, a soft number will open the door to a sharp equity rally and bond rally, with yields likely to even test the 4.0% level if the NFP number is soft enough.  I think we need a 100K or less number for a reaction like that.

Ahead of the data, there seems to be a growing concern over the outcome.  While Asian markets rebounded a bit, European bourses have started to fall across the board from earlier levels and are now all down by between -0.2% and -0.5%.  US futures, too, are now back to unchanged having spent the bulk of the evening higher on the back of a strong earnings report from Amazon.  

Bond markets are under pressure as energy prices around the world are rising, as are food prices, and so inflation prospects seem to be worsening.  This is despite the very earnest efforts of central banks around the world to convince us all that inflation has peaked, and they are near the end of their hiking cycles.  After the BOE raised rates by 25bps yesterday, the market has reduced the expected UK terminal rate down to 5.75%, two more hikes despite CPI running at 7.9% with Core at 6.9%.  In the Eurozone, the ECB has released a new report claiming that inflation has peaked as well, and the market has priced out any further rate hikes.  This all smacks of whistling past the graveyard in my view.

For instance, oil (+0.35%) is higher again, up more than 14% in the past month, and shows no signs of slowing down.  Not only did Saudi Arabia extend their one million bbl/day production cut for another month, but Russia now claims it will cut production by 300K bbl/day in September as well.  I haven’t discussed food prices in a while as they had eased off from the immediate post invasion highs, but the FAO Food price index rebounded last month and despite a sharp decline from its highest levels last year, is still at levels that have caused riots in the streets of African nations in the past.  Metals prices are also under pressure today, but that seems more to do with the strong dollar than anything else.  

Turning to the dollar, it is once again seeing demand as only NOK (+0.2%) has managed to gain on the greenback in the G10 space, although the other currencies’ losses are not large.  The same cannot be said for the EMG space where the APAC bloc is under real pressure led by KRW (-0.8%) and THB (-0.4%) on the dual concern of a slower growing China and broad risk-off sentiment.  One thing that seems likely is the dollar will benefit from a strong NFP print and suffer from a weak one.

And that’s really it for the day.  No Fed speakers are on the docket, but do not be surprised to hear some interviews if the number is very different from the forecasts.  In the end, nothing has changed my view that inflation will remain stickier than forecast and the Fed will hold tight thus supporting the dollar.  Remember, the combination of tight monetary and loose fiscal policy is the recipe for a strong currency.  And the US is running that in spades!

Good luck and good weekend

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Like Goldilocks?

Posted on by 
For assets so safe and secure
It seems bonds have lost their allure
Yields worldwide are rising
And it’s not surprising
Since ‘flation, we all must endure

The question is, what about stocks?
Are they set to soon hit the rocks?
Or will they remain
Resistant to pain
If growth behaves like goldilocks?

Certainly, yesterday was a pretty bad day for risk assets as equity markets in the US sold off aggressively along with commodities.  The thing is it was a pretty bad day for haven assets as well with Treasury yields rising sharply.  And right now, just before 7:00am in NY, those trends remain intact.  In fact, the only thing that seemed to perform well yesterday was the dollar.

So, what gives?  Many will point to the downgrading of the US credit rating by Fitch as the proximate cause of things, and it may well have been an excuse for some selling, but despite the logic I detailed yesterday, the impact on markets should be di minimis.  After all, Treasuries are used for two things largely, either as investments in their own right, or as collateral for other financial transactions.  Regarding the first point, nobody is actually concerned that the US will not repay their debt, so if the yield is attractive, investors will still buy them.  As to the second point, this could have been an issue but since the S&P downgrade in 2011, collateral agreements have been rewritten to accept not only AAA securities, but also US government securities, with no mention of their rating.  So, there is no change in the collateral situation.

If it was not the downgrade, then what has driven the recent upheaval in markets?  Arguably, this has been building for quite some time and was looking for a catalyst to get things started.  I think there are two ways to consider the situation.  For the bears out there, watching equities rally daily despite what appeared to be softening margins along with tightening monetary conditions didn’t make sense.  But the rally has been so relentless that the bears have largely capitulated on their views.  It seems the key lesson is that the timing of monetary policy transmission is much slower than it had been in the past, or at least that’s what it feels like, and so despite the Fed’s aggressiveness, it hasn’t had nearly the impact anticipated.  

To this point, remember, while the Federal government didn’t take advantage of ZIRP to term out its debt, homeowners and corporations did just that.  This has resulted in a lot of borrowers with a long runway before needing to refinance their debt and left them somewhat impervious to the Fed’s recent moves.  We have all heard that > 50% of mortgages outstanding are at rates < 4.0%.  This has resulted in an unwillingness to move and reduced existing home inventories and sales.  But all those people have not been impacted by the rate hikes, at least not on their largest single interest payment.  And the same has been true for many corporations who termed out their debt in 2020-2021 and even the first half of 2022.  While much of that debt will eventually be refinanced, it may be another 5-7 years before we start to see companies feel any stress there.  Consider, too, how this has helped lower rated companies, who, if forced to refinance today would see yields in the 8%-12% range but were able to borrow at 5% or less.  Of course, that debt was likely 5-year tenor, so that comeuppance is likely to arrive in 2025 or 2026.  And maybe that is when we should be looking for the first real problems.

The Fed’s Loan officer survey showed that conditions are continuing to tighten in the bank market, which means that smaller companies are going to be stressed, but the large cap companies that issue debt directly are sitting pretty.

Therefore, if it is not the downgrade, what other reasons could there be?  The first thing to remember is that there doesn’t have to be a specific reason for markets to sell off.  Markets that are overbought (or oversold) can reverse without any particular driver.  Historically, August has been a more volatile and weaker month for equities, often attributed to vacation schedules, with investors and traders both taking their summer trips and leaving skeleton staffs of junior people on the desk.  This will result in reduced liquidity and any outside selling impetus can have an overly large impact.  Remember, though, a rational look at equity markets indicates that on a historic basis they remain quite richly valued with the Shiller Cyclically adjusted P/E ratio at 31.1, well above its long-term median of 15.93.  However, what is typically true is that when an overvalued market starts to correct, it can continue doing so for quite some time until it reaches a more rational valuation.  If the bears have all given up, and the bulls are all on vacation, who is left to buy things?

All this is to say that, while the recent equity market weakness may not make sense specifically, there is nothing to say that it cannot continue for a while yet.  Turning to bonds, though, that is a different story.  Yields around the world are rising and, in many cases, rising sharply.  While the BOE just raised rates 25bps this morning, as largely expected, they are simply catching up to the rest of the G10.  However, 10-year Treasury yields are +6.7bps as I type (7:20) and now trading at 4.14%, their highest level since last October.  My sense is that this move is all about two things, concerns that inflation has seen a local bottom and the dramatic increase in supply just announced by the Treasury.  As discussed yesterday, yields above 4% have led to things breaking, so the question is what is set to break now?  Perhaps, the stock market selling off will be this breakage, or perhaps there will be some other crisis that flares up.  Maybe another large bank going to the wall, or a large corporate bankruptcy in a key sector.

We have discussed rising oil prices and you are all aware of rising gasoline prices every time you go to fill the tank.  Headline CPI, when it is released next week, will be well above last month’s 3.0%.  Too, yesterday’s ADP Employment number was much stronger than expected for a second consecutive month.  If the no landing scenario is correct, then inflation is likely to remain far more stubborn than currently expected and Chairman Powell will not be thinking about thinking about cutting rates any time soon.  In fact, at this point, if the Fed starts to think about cutting rates, that likely means that the economy has reversed course and is clearly headed into a recession.  Be careful what you wish for.

Summing up, I would be wary of reverting to the buy the dip mentality that has prevailed for more than a decade.  The underlying economic and financial situation is changing pretty quickly and that implies previous strategies may not perform that well.  Do not forget last year’s market performance.

I would be remiss if I didn’t mention that the BOJ was back in the market again last night, buying an unlimited amount of JGBs as they try to smooth the rise in JGB yields, which are now up to 0.65%.  This did help the yen a bit, which has rallied slightly on the day, but overall, the dollar remains much stronger.  My take is that we are seeing investors who are uncertain about the medium and long term, buying dollars to buy T-bills, earn a nice piece of interest and reconsider their next move.  One thing to note is that the yield curve’s inversion is lessening quite quickly.  Last Monday, the inversion was -104bps.  This morning it is -75bps.  That is a remarkably fast move in a short time.  It also implies that the demand for 10-year Treasuries is a little soft right now.  As I have written, this inversion could resolve with higher long rates, not lower short rates, and that is not something for which the market is prepared.  I believe that would be a clear equity negative.

There is a lot of data this morning starting with Initial (exp 225K) and Continuing (1708K) Claims, Nonfarm Productivity (2.3%), Unit Labor Costs (2.5%), Factory Orders (2.3%) and then ISM Services (53.0) at 10:00.  But this is all a lead-up to tomorrow’s NFP data.  Fed speakers have been fewer than usual, but we do hear from Richmond’s Thomas Barkin this morning.  I see no reason to believe that there will be any new dovishness upcoming.

To my mind, yields are going to continue to rise, equities are going to remain under pressure and the dollar, overall, is going to remain stronger rather than weaker.  We will need to see big changes in the data to change that view.

Good luck

Adf

Walk the Walk

Posted on by 
The Chinese are starting to feel
Recession could really be real
With PMI falling
Most pundits are calling
For policy help with more zeal

But so far, despite lots of talk
The Chinese will not walk the walk
One wonders how long
That they’ll sing this song
And when they’ll stop acting the hawk

Right now, the face of ‘all talk, no action’ is Chinese President Xi Jinping.  China’s economy has been slowing, or perhaps a better description is that the post-covid performance has been much less dynamic than had been widely anticipated.  Amongst the more concerning lowlights is the incredibly high youth unemployment rate there, with >21% of the population aged 18-24 unable to find work.  That is not the sign of economic dynamism.  You may recall the enthusiasm that greeted the news that the Covid lockdowns had ended suddenly in January and there was a widespread call for a rally in commodity prices in anticipation of the great reopening.  It never really happened.  Since then, things have been lackluster at best and the Chinese government has grown increasingly concerned.  However, they have not yet grown concerned enough to act in any significant way with fiscal policy support extremely narrow and inconsistent.

Last night simply reinforced these themes as the Caixin PMI Manufacturing data was released at 49.2, a full point below expectations and, of course, below the key 50 level indicating growth.  This was the lowest print since December, but a quick look at the numbers since then shows a very limited growth impulse in China.  The average reading in 2023 has been 50.1, hardly a sign of a rebound.  Now, the Chinese government did come out and say they are going to increase credit to private companies, focusing on small firms and the central government called on cities and provinces to do more to support the property markets.  But talk is cheap and until we see real money getting spent, it is hard to get excited about the Chinese economy.  Ultimately, while the PBOC is very concerned that the renminbi could fall sharply if they loosened their grip on the currency, I expect that a weaker CNY is going to be a theme for the rest of this year, and probably most of next year, as it offers the one release valve that they have available.  7.50 is still in the cards.

Away from the China story, the market’s focus on central banks intensified as the RBA left rates on hold at 4.10% despite market expectations of a 25bp rate hike.  The first casualty of this surprise was the AUD (-1.3%) which is the worst performing currency across the board today.  Apparently, their concern is that growth is faltering, and given the lack of growth in their largest export market, China, they believe that inflation pressures are ebbing and they have achieved their objectives.  Like all central banks these days, they claim to be data dependent and right now the data are telling them not to worry.  I guess that means when if inflation starts to reaccelerate, they will be back at the hiking game.  But for now, like central bankers all over the world, they are eager to claim victory over inflation.  

We heard this from the ECB last week, and it is quite possible that the BOE hints at that on Thursday as well, although inflation is much stickier in the UK than elsewhere.  My point is that the one central bank that is not satisfied is the Fed, where there is still a very wide consensus that the job is not done.  As long as US economic activity remains the best around, and that seems highly likely for another few months at least, it is hard to see any other central bank maintaining a more hawkish stance than the Fed.  Again, the underlying thesis of dollar strength is the Fed will be the most hawkish of all, and nothing we have seen today would contradict that theory.

How have markets responded to this news?  Well, yesterday saw a very late rally to take the US indices higher on the day, but only just, and while the Nikkei (+0.9%) had a good session, continuing its recent run, Chinese stocks, not surprisingly, were weighed down by the baggage of the PMI data.  Europe is also feeling the brunt of weak PMI data as the Manufacturing prints there were all in the low 40’s, except for Germany which managed to remain unchanged at 38.8!  Virtually all the markets on the continent are down by around 1% this morning in response to the data.  In fact, it is data like this that helped inform Madame Lagarde’s belief that the ECB is done, and who can blame her.  While inflation may be a problem, and the ECB’s only mandate, given she is a politician first and central banker second, the optics of tightening policy into a rapidly declining economy would be very difficult to explain.  Again, this bodes well for the dollar overall.  As to the US futures market, they are a bit softer this morning, not dramatically so, but it seems that there is some response to a generally softer tone in the earnings numbers released to date.

Interestingly, despite equity weakness, bond yields are higher in the US and across Europe by a few basis points.  For some reason, the bond market does not seem to agree with stocks, nor it seems, with most central bankers.  Inflation concerns remain top of the list for bond investors, and other than Down Under, where AGBs fell 8.6bps after the RBA left rates on hold, there seems to be a growing worry that the central banks are ending their fight too soon.  As to the US, once again the 10-year yield is approaching 4.0%, clearly a level of great import to the market.  I would also note that JGB yields edged ever so slightly lower overnight and remain below 0.60%.  However, it is still early days with respect to the policy changes there, so the eventual outcomes are still unclear.

Oil prices are very little changed today, consolidating their recent gains.  This must be a concern for the central banks as evidence of slowing economic activity is not leading to slowing demand for oil.  That is a key tenet of their policy structure.  The belief is weaker growth and recession will reduce demand for energy first, and then other things thus reducing inflationary pressures.  But if growth weakens and oil stays firm or rallies, they have a big problem.  Now, the metals complex is all softer this morning, behaving as would be expected in a weakening growth scenario, so it is oil that is the current outlier.

As to the dollar, it is king of the hill this morning.  While Aussie is the weak link, all the commodity currencies are under pressure, down between -0.6% and -0.9%.  But the yen (-0.5%) is also failing to find support on a risk-off day, which comes as a bit of a surprise to all those who continue to believe the BOJ is going to alter policy further.  Here, too, I see further weakness vs. the dollar as time progresses.  Just wait until the Fed hikes again and sounds hawkish as CPI data rebounds.

In the emerging markets, ZAR (-1.4%) has now edged ahead of the Aussie for title of worst of the day, as a response to the Chinese data, its own weak PMI reading and declining metals prices.  But virtually the entire bloc is weaker today with all three geographic areas feeling the pain.  

Yesterday’s US data was definitely soft with Chicago PMI at 42.8 and Dallas Fed at -20.0.  As well, the Senior Loan Officer Opinion Survey indicated that credit conditions for commercial and industrial loans had tightened further with reduced demand to boot.  In fact, the tightening is reaching levels last seen during the covid recession and the GFC.  This is not indicative of a soft landing, rather of a much harder one.  This morning we see Construction Spending (exp 0.6%), JOLTS Job Openings (9600K) and ISM Manufacturing (46.9) all at 10:00am.

And yet, despite the data and SLOOS, we heard from Goolsbee and Kashkari that they continue to believe a recession will be avoided.  This morning, Goolsbee is back on the tape, but we already know his view.  However, I do not believe he is in the majority at this point, though he is a voter, so come September, if they hike, perhaps we will have a dissent.

If the data is terrible, perhaps we will see the dollar cede some of this morning’s gains, but absent that outcome, let alone surprising strength, it feels like the dollar has further to rally.

Good luck

Adf

No Longer Clear

Posted on by 
Inflation remains
Far higher than desired
Will Ueda-san blink?

Which one of these is not like the other?

 

Central Bank

Policy Interest Rate

Core CPI

Federal Reserve

5.25%

5.3%

ECB

4.00%

5.3%

BOE

5.00%

7.1%

Bank of Canada

4.75%

4.2%

RBA

4.10%

6.8% (headline)

BOJ

-0.10%

3.2%

Source: Bloomberg

 

Japanese inflation readings were released overnight, and they showed no signs of declining.  In fact, they were actually a tick higher than the median forecasts.  However, there has been zero indication that the BOJ is set to respond to the highest inflation in decades.  As everything economic is political, by its very nature, the reality seems to be that there is not yet any political price for PM Kishida to pay for rising inflation.  Recall, as inflation started to pick up sharply in the wake of the pandemic reopenings, the universal central bank response was, inflation is transitory and it will subside soon.  Politically, at that time, governments were keen to keep interest rates near (or below) zero as part of their belief that it would foster economic activity and recession was the big concern.

 

However, once it became so clear that even central banks understood this bout of inflation was not a transitory phenomenon, policy prescriptions changed rapidly leading to the very rapid rise in interest rates we have seen since early 2022.  Politically, inflation was the lead story in every media outlet with governments around the world and their central banks being blamed, so they had to respond.  (Whether their response has been effective is an entirely different story).  Except in one place, Japan.  As is abundantly clear from the table I constructed above, the BOJ has yet to alter their monetary policy stance despite core CPI remaining at extremely elevated levels far above the BOJ’s 2% target.  In fact, prior to the recent spike, you have to go back to 1981 to see Japanese core CPI this high.

 

Apparently, though, inflation is not making headlines in Japan as it has been throughout the rest of the G7 and so the BOJ is perfectly happy to continue on their path of infinite QE and YCC.  Remarkably, 10-year JGB yields fell further last night, now around 0.35%, as there is seemingly very little concern that a policy change is in the offing there.  Certainly, there has been no indication from any BOJ commentary nor from Kishida’s government.  As such, it can be no surprise that the yen continues to fall, declining 1% this week and more than 3% over the past month. 

 

Interestingly, there has definitely been an uptick in the buzz from market talking heads about the need for the BOJ to abandon YCC and that a change is imminent.  I have seen a number of analyses that foretell of the inevitable change and how the yen is likely to rise dramatically when it happens.  FWIW, which may not be that much, I agree that when the BOJ does change policy, we are likely to see the yen rally sharply.  The problem is, I see no indication that is going to happen anytime soon.  Show me the headlines in the Asahi Shimbun or the Nikkei Shimbum (major Japanese newspapers) that are focused on inflation and I will change my view.  But until it is a political problem, the BOJ is serving its current function of supplying the world’s liquidity with a correspondingly weaker yen as a result.

The messaging’s no longer clear
Regarding the rest of the year
While some at the Fed
See more hikes ahead
Some others feel ending is near

Once again yesterday we heard mixed messages from Fed speakers with some (Barkin) talking about evaluating their actions so far and waiting for more proof that further tightening was needed while others (Bowman, Waller) seeming pretty clear that more hikes are in the offing.  Powell’s Senate testimony was largely the same as the House testimony on Wednesday with more of the questions focused on bank capital rather than monetary policy.  Of course, the big question remains, are they done or not?  Fed funds futures are still pricing a 72% chance of a hike in July and a terminal rate of 5.33%, so one more hike from current levels.  But the arguments on both sides remain active.  It appears to me that as long as the employment situation remains robust, they will continue to hike until inflation falls closer to their target.  Yesterday’s Initial Claims data printed just a touch higher, 264K, and the trend certainly seems to be moving higher, but is not nearly at levels consistent with recession.  The NFP report in two weeks will be critical but until then, we are likely to be whipsawed by commentary.

 

As to the overnight session, risk is very definitely on its heels this morning with equity markets in the red around the world, with all of Asia falling by -1.5% or more although European bourses have not suffered quite as much, -0.3% to -0.8%.  US futures are also under pressure, down about -0.5% at this hour (8:00).

 

Bond markets, on the other hand, are performing their role as safe haven, with yields sharply lower this morning. Treasury yields, which had risen yesterday have given all that back and then some, down 6bps, while in Europe, sovereigns are down 12-13bps virtually across the board.  The latter seems to be a response to the Flash PMI data which was released showing slowing activity across the continent, especially in France where both Manufacturing and Services fell below 50 and where German Manufacturing PMI tumbled to 41.0.  If the Eurozone economy is truly performing so poorly, it is hard to believe that the ECB will continue on its current path much longer.  One other rate story is the short-term GBP rates which are now pricing a terminal rate by the BOE at 6.13%, pricing another 5 rate hikes into the curve by the middle of next year.

 

However, on this risk off day, it is the dollar that is truly king of the world, rallying vs every one of its counterparts in both the G10 and EMG.  NOK (-2.2%) is the G10 laggard on the back of general risk aversion as well as the fact that oil prices are tumbling again, down a further -1.25% this morning on the recession fears.  But the weakness is pervasive with AUD (-1.0%) weak and the euro (-0.7%) giving up chunks of its recent gains in short order.  Interestingly, the yen (-0.1%) is the best performer in the G10.  The picture in the emerging markets is similar, with substantial losses across the board led by TRY (-1.3%) and ZAR (-1.1%).  Of course, Turkey’s lira is destined to continue collapsing given the dysfunctional monetary policy there, but ZAR is feeling the pressure of declining metals prices, especially gold, which is down again this morning and now pressing $1900/oz.  Meanwhile, China’s renminbi continues to slide, trading to new lows for this move with the dollar marching inexorably higher.

 

On the data front, today brings Flash PMI data (exp 48.5 Manufacturing, 54.0 Services, 53.5 Composite) and that’s it. Two more Fed speakers, Bullard and Mester, are due to speak and both have been leading hawks so we know what to expect.  So, looking at the rest of the session, I suspect that the dollar will maintain most of its gains, but do not be surprised to see a little sell off as we head into the weekend and positions are reduced.

 

Good luck and good weekend

Adf

A Pitiful Claim

Posted on by 
Said Jay, we’ve “a long way to go”
Ere driving inflation too low
Employment’s still tight
But we’ll get it right
Or not… it’s too early to know

His colleagues, though, aren’t in sync
As some of them seemingly think
They’ve tightened enough
And now would rebuff
The call for more Kool-Aid to drink

Lots to touch on this morning between Powell’s testimony yesterday along with other Fed speakers and then a raft of central bank meetings with rate hikes across the board.

 

Starting with the Fed, Powell tried to be very clear that his expectation, and that of the bulk of the FOMC, is interest rates have further to rise.  While they chose to skip a hike last week, they are under no illusion that they have beaten inflation.  Instead, Powell was very clear in his comments that they “have a long way to go” before they have finished the job with inflation.  Of course, yesterday I laid out a theme of why their medicine for inflation is not likely to be that effective, but that is not a conversation that Powell, or any FOMC member, is likely to entertain.

 

However, despite Powell’s insistence that there are likely two more 25bp rate hikes in the offing, we are finally beginning to hear some dissent from the rest of the committee.  Yesterday both Raphael Bostic from Atlanta and Austin Goolsbee from Chicago were clear that a pause at the current level made the most sense and they would support that outcome.  While Governor Christopher Waller remains on board with further rate hikes, Bostic is not a voter (Goolsbee is) so I expect that the July meeting will have a lot of discussion.

 

Interestingly, the market reaction was different in different markets, with the equity markets hearing Powell and accepting his words at face value thus selling off, while the FX market seems more suspect, with the dollar failing to gain after his comments.  In fact, the euro has traded back above 1.10 this morning for the first time in more than a month.  As to the Treasury market, yields are pushing higher again, with 10yr yields up by 1.5bps this morning, but the real movement has been in the 2yr which has seen the curve inversion push back to -99bps.  Bond investors seem to believe Powell.

In Europe, though, things ain’t the same
As central banks still try to blame
Their failure to slow
Inflation and grow
On Russia, a pitiful claim

In the meantime, three central banks met today in Europe and all three hiked rates, with two, Norway and the UK, hiking by 50bps and Switzerland hiking just 25bps.  The 50bp hikes were more than expected and indicative of the fact that both nations, and in truth the entire continent, remain far behind the curve in their respective inflation fights.  Alas, for these nations, too, I fear they are not using the best tool to address the issue as all were guilty of excessive fiscal stimulus and all face worse demographic trends than the US, so are unlikely to get the desired response from rate hikes. 

 

It should be no surprise that both the pound and krone have rallied sharply on the day, with NOK higher by 1.3% and the best performing currency in the world, as investors and traders are concluding that these central banks are going to keep at it until such time as inflation finally does slow down.  The pound reacted immediately, with a quick 0.5% pop, although it is since retraced those gains and is only slightly higher on the day now. 

 

What should we make of all this central bank activity?  While there are a growing number of analysts and economists who continue to believe that inflation is due to decline sharply over the summer, apparently none of them work in any central bank.  The relative amount of tightness from one bank to another may vary slightly, but other than the BOJ, which is completely uninterested in adjusting its policy anytime soon, it is very easy to believe that interest rates have higher to go from here.  Plan accordingly.

 

So, what have these comments and actions wrought in markets?  Well, my entire equity market screen is red this morning with Japan and China both sharply lower as well as every major index in Europe falling by at least -1.0%.  US futures are also in the red after a weak session yesterday, and it is very easy to believe that we are due a correction, if nothing else, given the remarkable run up we have seen lately.

 

Bond yields, as mentioned above, are generally higher, although 10yr Gilts are bucking the trend, falling 3bps in the wake of the BOE action as investors are hopeful they are truly going to be able to halt the inflationary spiral.  As with most other things, JGB’s are not following suit and in fact, with the 10yr yield back down to 0.367%, virtually all discussion of the end of YCC has vanished.  Ueda-san is one lucky guy.

 

On the other hand, oil (-2.1%) is under pressure this morning as the idea of higher interest rates slowing economic growth continues to pervade the market.  Perhaps more surprisingly, both copper and aluminum have rallied a bit and are holding onto their gains in the face of higher rates.  Ultimately, copper especially, is a resource that is in short supply for all the grandiose electrification plans that are bandied about by politicians worldwide, and so I expect, just like oil, there is a structural deficit and it should trade higher.  I am simply surprised it is doing so in the current environment.

 

Finally, the dollar is mixed this morning, as after the NOK, the rest of the G10 is +/- 0.2% from yesterday’s closing levels, hardly enough to discuss.  In the emerging markets, the biggest mover is TRY (-2.3%) after the central bank disappointed by only raising rates from 8.50% to 15.0%!  With a new central bank chief, the market was expecting a move to 20.0%, which would still be far below the current level of CPI there, which at last reading was 39.6%.  But away from that, the dollar is mixed with no outliers in either direction.

 

Today we do get a lot of data as follows: Chicago Fed National Activity Index (exp -0.10); Initial Claims (259K); Continuing Claims (1785K); Existing Home Sales (4.25M); Leading Indicators (-0.8%) and KC Fed Manufacturing Index (-5).  Chair Powell also speaks to the Senate Banking Committee today, but I doubt much new will come from that.  Look at the Initial Claims data, which is the best real time indicator of the employment situation as any jump there will likely get tongues wagging about the end of the Fed rate hikes.

 

Right now, investors are a bit nervous about just how hawkish the Fed is going to ultimately be, so my take is we will see caution, meaning profit taking and a modest correction in risk assets, until such time as participants are all convinced that the pivot is coming.  The fact that a pivot means the economy is distressed does not seem to matter right now. As to the dollar, it will have a hard time as long as traders question the Fed’s conviction while other central banks raise rates.  So, while the yen and renminbi should be the worst performers, the G10 is likely to outperform the buck for now.

 

Good luck

Adf

Policy Lies

Posted on by 
In China Xi’s growing concerned
That growth there will not have returned
Ere folks recognize
His policy lies
And seek changes for which they’ve yearned

So, last night they cut interest rates
While hoping it’s this that creates
The growth that is needed
So, Xi’s unimpeded
In ending all future debates

It has been another relatively dull session in markets as we are well and truly amid the summer doldrums despite solstice not arriving until tomorrow.  After an action-packed week with numerous central bank meetings as well as key inflation readings, this week is looking a lot less interesting.  From a market perspective, the most noteworthy news from overnight was the reduction in the Loan Prime Rate in China by 10 basis points, matching what we saw in their repo rates last week.  This is a very clear signal that there is a growing concern at the top in China regarding the growth trajectory of the country. 

 

Perhaps the most interesting part of this situation is the reversal of previous policy attempts to reduce property speculation with the latest message encouraging people to buy a second home!  It was only a few years ago when China, having massively leveraged its economy to generate their much vaunted 6% growth rate, realized that too much debt could turn into a problem.  This led to a policy change that discouraged property investment and ultimately led to the decimation of the property sector.  China Evergrande was the first major problem revealed, but there have been numerous other companies whose business model collapsed along with many people’s life savings. 

 

However, lately that story has been just background noise and represented just one of the many industries that the Xi government helped undermine.  You may recall the education (tutoring) companies that were turned into non-profits overnight, and the fight against the large tech companies like Alibaba and TenCent, which were deemed to be getting too powerful.  But a funny thing about a state-controlled economy is that business decisions made by government actors are typically abysmal and lead to further problems.  So, when the government decided that property speculation was bad, they cracked down hard.  But now that they are figuring out that much of the country’s wealth was tied up in the market they cracked down on, and that people reduced their economic activity accordingly, they realize that perhaps things were better with that speculation, at least politically.  Hence the reversal where the government is now encouraging that purchase of a second home.  You can’t make this stuff up.

 

At any rate, the one thing that is very clear is that the Chinese economy is continuing to drag and that the most natural outlet remains the renminbi, which weakened further last night (-0.3%) and continues to push toward the renminbi lows (dollar highs) seen in November 2022.  Given inflation remains extremely low there and given that the only model that the Chinese really know, the mercantilist export driven process, benefits from a weaker CNY, I would look for this trend to continue for quite a while going forward.

 

Otherwise, last night saw the release of the RBA Minutes which indicated that the surprise rate hike of a couple weeks ago was a much more closely debated outcome than previously thought.  This has led traders to downgrade their assessment of a rate hike next month and Aussie (-0.9%) fell accordingly.

 

Beyond those stories, though, there is precious little to discuss today.  Risk is on its back foot with equity markets in Europe mostly under pressures, and Chinese markets, especially, seeing weakness led by the Hang Seng’s -1.5% performance.  US futures are also a bit lower at this hour (7:30) following Friday’s lackluster session.  As discussed yesterday, there remains an active dialog between the bulls and the bears, with the bulls having the better of it for now, but the bears unwilling to give in.  My working assumption is we need that to occur before things can turn around, so we shall see.

 

As to the interest rate outlook, opposite the Chinese rate cuts, the Western markets continue to price in further rate hikes as inflation remains far above target levels throughout 6 of the G7 with only Japan maintaining their current QE/NIRP policies.  I think of greater concern for many economists is the fact that the inversion of the Treasury curve is not only substantial but has been increasing lately and is pushing back to -100bps for the 2yr-10yr spread.  Perhaps, after 11 months of this price action, the question needs to be asked if this is a natural occurrence and a clear signal for a recession in the not too distant future, or if there is something else happening, perhaps an artificial bid in the back end via Japanese QE, maintaining much lower than realistic long-term rates as a way to prevent the US government’s interest expenses from rising too rapidly.  With that as backdrop, though, it must be noted that European sovereign markets are much firmer this morning with 10-year yields all sharply lower, 6bp-7bp on the continent and 14bps lower in the UK after a new issuance with the highest coupon (4.5%) in decades drew substantial demand.

 

In the commodity markets, oil is relatively flat today having recaptured the $70/bbl level last month and to my mind seems to have found a bottom.  While gold is flat and continuing its consolidation, base metals markets are under a bit of pressure on this risk off day.

 

Finally, the dollar is generally a bit stronger, at least vs. its G10 counterparts, with only the yen (+0.4%) showing its haven characteristics while essentially the rest of the bloc has fallen about -0.35%.  In the emerging markets, the picture is more mixed with about half the currencies slightly stronger and half weaker but none having moved more than 0.3% in either direction, an indication that this is positional not newsworthy.

 

Looking ahead, this week brings mostly housing data but of more importance, we hear from Chairman Powell twice as he testifies to both the House Financial Services Committee and the Senate Banking Committee tomorrow and Thursday respectively.  We also hear from the BOE on Thursday with another 25bp rate hike expected there.

 

Today

Housing Starts

1400K

 

Building Permits

1425K

Thursday

Chicago Fed National Index

-0.10

 

Initial Claims

260K

 

Continuing Claims

1785K

 

Existing Home Sales

4.25M

 

Leading Indicators

-0.8%

Friday

Flash PMI Manufacturing

48.5

 

Flash PMI Services

54.0

 

Flash PMI Composite

53.5

Source: Bloomberg

 

I think we can expect Powell to continue the hawkish rhetoric and he will do so until either inflation is very clearly lowered, as measured by the regular data, or until the Unemployment rate starts to rise sharply.  However, the market is becoming of the opinion that Madame Lagarde and Governor Bailey will be more hawkish than Powell.  This has been the driver for the dollar’s relative softness over the past month.  In contrast, I remain quite confident that if Powell does pivot, it won’t be long before both the ECB and BOE do the same.

 

Good luck

Adf